If you has only a passing interest in oil prices, it was not hard to notice the gaping price disparity between the two most widely quoted indexes, the current month Brent crude futures versus WTI (West Texas Intermediate), In the days prior to contract expiration in December, WTI traded as much as $9 below Brent. Right now, with January expiration near, the disparity is a flat $10, with Brent at $46.20 versus $36.20 for WTI.
That, of course, makes no sense. The culprit is limited storage in Cushing, Oklahoma. As Eugen Weinberg, a commodities specialist with Commerzbank, pointed out last May:
The West Texas Intermediate oil contract, based on delivery in Cushing, Oklahoma, is good for 300,000-400,000 barrels per day. The storage capacity in Cushing is about 20.5m barrels. The trading volume on which that is based is between 500m and 600m barrels per day. If you are going to manipulate the price, you would think about doing that in Cushing.
Now it may be that the oil glut is showing up even worse in Cushing than elsewhere because above ground storage is maxed out (even ships are full), or it may also be the evil specs. But the initial reaction among traders is to treat WTI warily.
From the Financial Times:
The surge in oil inventories in Cushing, Oklahoma, where WTI is delivered into America’s pipeline system, has depressed its value not only against other global benchmarks, such as Brent, but also against other domestic US crudes.
Julius Walker, an oil market analyst at the International Energy Agency in Paris, said there was “anecdotal evidence” of traders moving away from WTI and “doing deals based on other US oil benchmarks”.
The IEA monthly report said Brent was now “arguably more reflective of global oil market sentiment”. However, Bob Levin, managing director of market research at Nymex said that the WTI contract was performing “transparently”, reflecting a “loss in oil demand and sharply rising inventories”.
“WTI is better reflecting global oil fundamentals than Brent,” Mr Levin said. “The oil industry has not abandoned the WTI contract and it has confidence in it.”
Nevertheless, traders in London, New York and Houston confirmed a small number of transactions away from WTI after its price plunged last week to record discounts against other global and domestic benchmarks. The traders cautioned that the move could reverse if the WTI situation normalised. Lawrence Eagles, at JPMorgan, said any move away from WTI would face “strong resistance as none of the other US benchmarks have the price transparency of an exchange market”.
Highlighting the price disconnection with the global market, WTI, which usually trades at a premium of $1-$2 a barrel to Brent, last week plunged to an all-time discount of $11.73. The detachment hit the US market too, where Light Louisiana Sweet, jumped to a $9.50 premium, the highest in 18 years.
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Good post, as usual.
A lot of benchmark financial ratios do not seem robust enough to hold up to the major market stresses. I’m thinking about LIBOR (which seems to have failed for a different reason), and my usual whipping boy, the CDS market.
You have to wonder exactly how accurate WTI was during the run up to $150 BBL 6 months ago.
Anyway, the oil and gas journal supports the problems in Cushing. http://www.ogj.com/display_article/350581/7/ONART/none/GenIn/1/MARKET-WATCH:-Crude,-gas-prices-fall/
“Because of minimal storage capacity at the Cushing delivery point, physical traders are selling WTI positions ahead of the contract expiration to avoid delivery. “With inventories at record highs, oil tankers sitting idle at sea hoarding oil, and total US petroleum demand down 7% compared with last year, the price disparity between WTI and Brent could linger for months,” analysts said.
Paul Horsnell at Barclays Capital Inc., London, said although 18.1 million bbl of crude have poured into Cushing over the last 3 months, supplies at other US storage points are 40 million bbl lower than in mid-2007 (OGJ Online, Jan. 15, 2009).”
Do you have any similar info on Brent trading e.g. storage limits, etc? I’m not sure how Brent futures settle physically, and a quick look at the contract terms on ICE’s website doesn’t provide any such information (or indeed if there even is a central delivery point).
That said, IMHO, I think the traders are engaging in wishful thinking. The current contango is way outside historical ranges. I guess which futures contract you choose to believe, WTI or brent, depends on whether you believe the current contango is justified or not.
Having Cushing storage maxed out means that current production is finally in line with current consumption, and people can no longer store excess production in the hopes that future consumption will rise. So no more playing the carry trade.
IMHO, given the inability to further the physical contango, the WTI futures now reflect true matching of current production with current demand, while Brent is likely still showing the effects of producers stockpiling production excesses.
Now believers in the current contango may be right, that the severe drop in consumption witnessed in the last several months will sharply reverse in the next 6-12 months. But my suspicion is that it will take longer than that to get the world’s economy rolling again, and that therefore all the producers stockpiling current production in the hopes of higher prices later are in for a rude awakening.
As much as oil traders may wish WTI prices to be higher, I think it’s Brent that needs to come down, not WTI to come up.
P.S. Quick correction Yves: Cushing is in Oklahoma, not Texas.
Shouldn’t this be an arbitrage opportunity? Buy WTI, sell Brent?Eventually the situation will normalise… you’d think…
Would the negative carry be prohibitively high? Or are there simply not enough traders left that are willng to bet that they can stay solvent until the market stops being irrational?
It seems to me that WTI’s restriction to Cushing storage prices has pros and cons. Cushing crude storage is constrained, therefore it appears to react to “exogenous” storage constraints.
But it can be argued that those constraints are not exogenous. There is a great deal of refining capacity there. If the refinery is running full-tilt, then one could say that the storage constraint is perhaps binding. But otherwise, neither storage nor refining capacity is a binding constraint. In that case, the Cushing pricing is reflecting current weakness in refined product markets.
The weakness in refined product markets is shown less clearly with other crudes that lack the storage constraint. For those crudes, even if refined product markets are weak, crude may be bought and stored in anticipation of future strengthening of product markets, other economic or political concerns, etc.
The front end of the forward curve is depressed for WTI, not the back. Therefore if you bought say March WTI futures and sold the March Brent futures, you would have to expect the steep WTI contango to correct within a month. That’s not guaranteed at all, driven as it is by the fundamental factors we have discussed.
Someone please explain why pump prices are up 13% this month in southern California. Refining capacity constraints again?
There’s been a tremendous drop in demand, as there would be, with the fall-off in the global economy.
So what price oil, conservatively most of what comes out of the ground is still less than $20 a barrel?
Oil has never been much of a “market,” that said, full humming global economy of the last five years was showing real supply constraints, it’s a real problem.
Yves, You are comparing different expiry months. Brent expires 5-6 days before WTI, and because of the steep contango, it is important to compare equivalent expiry months.
The difference in March contracts is about $4 and it never traded at $10 as you claim. Naturally, $4 is historically high.
Andreacaslotti,
I’ve watched the contract overlap period with some interest since early in the year, and I do not buy the steep contango argument. It has persisted so long and is so extreme that the usual defense, that it is just a short term glut and prices will rebound soon, does not strike me as valid. I keep getting information suggesting that the demand and price trends are down for the near-intermediate term, and with ships full of oil, we are reaching the limits of physical storage. Philip Verlerger estimated a month ago that stored crude was at 63 days of production, a record. And it has gotten worse since then.
as per nymex’s website, only 1% of all wti futures contracts settle physically. then imagine how much more distorted the oil futures market is in reality.
Brent settles financially. The distortion in WTI (at Cushing, which the contract represents) is caused by full storage and possibly pipeline issues. Physical oil markets are radically different as evidenced by the price of LLS at WTI+ 9.50, meaning that physical oil (other than Cushing WTI) is trading much closer in price to Brent than the headline frontline futures would have you believe.
There is a contango in physical prices for crude elsewhere but nothing as aberrant as the WTI futures price. OPEC and other producers have simply not adjusted production quickly enough to match a rapid decline in demand. OPEC and Russia are going bust at these prices, but are trying to survive by maintaining volumes. They can’t afford to but production at these prices.
is the contango result of increasing reserves or the opposite: the contango leads to increase in physical reserves?
my argument: 99% of nymex volume is cash settled. therefore the oil futures price has to reflect fundamentals rather than be significantly impacted by storage issues.
most speculative money from outsiders (not specialized in oil speculators) invest in the front month and now the short side is trendy. thus they create a contango. the only way to profit from a contango is if you take physical delivery and wait out this artificial push down. this in turn leads to reserves build-up and creates storage issues.
any flaws in my thinking?
Front month (M1) CL closed at $36.51/b Friday; Brent closed at $47.40/b (if Platts is to be believed–which isn’t a given.)
Brent is a financial contract on NYMEX; on ICE it is physical.
According to Bloomberg on the 14th, the EIA reported that Cushing stocks were at 33 million barrels at the end of the week ended January 9, and I am unsure of how Eugen Weinberg arrives at his number. Total storage numbers in the US are not even the highest seen in a 5 year historical range, so unless a bunch of tanks have been closed or otherwise realigned, or more than 8% of the world’s VLCC fleet was at sometime being used for storage in the last 5 years, there is more storage available … somewhere.
It has occurred to me that perhaps an entity or two is keeping some storage offline … as it is clear that arbitrageurs should have dealt with this contango some time ago.
ICE Brnt is not physical.
The demise of WTI has been predicted for years. It’s still here. But, maybe this time it will be replaced by some other benchmark… we shall see.
The contango is a function of financial speculation deep in the term structure (long-only funds and the like) I believe, plus the impact of the credit crisis. The gas market is also in a steep contango, unlike any since Brian Hunter was kicking it around. And there is plenty of storage for gas this summer.
I wrote about the subject of contango, speculation, and physical storage in the comment here .
What a great way to crush the oil speculators, a delivery point with an obvious bottleneck in capacity. Unleash the hounds, short the contract into oblivion and no one has the ability to arbitrage it back to the usual perspective. Meanwhile the buyers of the long contract lose 25% of their total investment EVERY MONTH as the front month contract gets mercilessly beat down. Blame it all on supply overwhelming demand, even though supplies around the rest of the world, or country, don’t reflect that fact. Just supplies in Cushing.
Looks like someone got a little po’d by that early 08 oil spike. The payback is not pretty for the speculators.
Freude Bud: Spot month WTI is February, Spot month ICE is March. WTI March settled @ 42.57 I believe.
Looking at the WTI vs Brent spread is easy but not very informative. You are better off looking at other American delievered grades of Crude. It paints a picture of a market that is being distorted.
Look at the historically big spread between WTI and LLS (Light Louisiana Sweet). It traded $7 over WTI last week. HLS (Heavy Louisiana Sweet) was $3.50 and higher. Mars Sour traded premium to WTI last week. Its normally $4 or more under WTI.
William Mitchell said…
Someone please explain why pump prices are up 13% this month in southern California. Refining capacity constraints again?
Yes. All up and down the West Coast.
[quote] Hamilton, whose group represents gasoline retailers, said fuel supplies are a bit reduced on the West Coast, partly because of a refinery fire in Alaska and the shutdown of another refinery in Bakersfield, Calif., as the result of financial problems.
Statistics on gasoline production, compiled by the California Energy Commission, do show a production downturn in that state. While similar statistics for the state of Washington were not immediately available, the Energy Information Administration also shows a small decline in overall West Coast production in recent weeks.
Besides the disruptions at the refineries in Alaska and Bakersfield, Hamilton said the oil refiners may be trimming production a bit in response to falling demand.[/quote]
http://www.bellinghamherald.com/255/story/752053.html
I’ll say it again, look at product markets.
Bulk gasoline is $1 a gallon. Service station owners are making a mint these days, buying it for $1 and selling it for $2. That really should be investigated (by Congress), why are retail prices not coming down.
I don’t think diesel / gasoil are all that high either.
With products so cheap, the anomaly is that the non-WTI crudes are as high as they are at the front. Or for that matter in the rest of the curve.
This whole oil pricing market is sh*T. Only thing consistent regarding the oil market is the huge profits.
Lets not forget in a commodity profits are slim. Oil profits have been slim since 1992 and stopping in 2000. Then oil acted like technology, all new and no competition?
With the amounts of profit you would think oil is a very new technology?
When oil was $147/barrel the rational was China’s consumption. Then it fell of a cliff (from my point of view was reacting to the general economies drop off – keeping the voter’s placated). Do you think China’s consumption of the stuff dropped off the cliff?
We here in America are chumps!! We are using all this economic reasoning (?) to justify stealing?
“Economists know the price of everything and the cost of nothing!”.
@ expat, no it is physical:
“Delivery/Settlement Basis: The ICE Brent Crude futures contract is a deliverable contract based on EFP delivery with an option to cash settle, i.e the ICE Brent Index price for the day following the last trading day of the futures contract.”
EFP = exchange of futures for physical
see: https://www.theice.com/productguide/productDetails.action?specId=219
@ drfinn: Yes, I understand front WTI is NYMEX CL Feb 2009—-and the closing price Friday was $36.51/b. Part of the issue is that expiry is coming up tomorrow.
The spread on Mars is very unusual, just as the CL-B spread is very unusual.
Looks from ICE, though,https://www.theice.com/productguide/productDetails.action?specId=219 that Platts reported wrong, and that March 2009 B closed at $46.57/b:
@ anon 10:08, traders are not necessarily bound to Cushing delivery:
“A seller or buyer may agree with the buyer or seller with which it has been matched by the Exchange under Rule 200.15(E) to make and take delivery under terms or conditions which differ from the terms and conditions prescribed by this Chapter. In such a case, Clearing Members shall execute an Alternative Notice of Intention to Deliver on the form prescribed by the Exchange and shall deliver a completed executed copy of such Notice to the Exchange.”
http://www.nymex.com/rule_main.aspx?pg=63#200.20B
Beyond that, all you need for regular delivery is pipeline access to TEPPCO or Equilon storage, which presumably includes TEPPCO pipelines, which have access points through TX and NM.
That ain’t distortion that’s flat ass manipulation by the broker dealers. The same den of thieves that brought you 147 dollar oil.
I’ve seen this Brent/WTI distortion commentary at several sites now. If you look back at the spot prices from EIA , it is not so obvious that this divergence is all that unusual. There have been many periods in the past where Brent traded at a premium to WTI. Also, there was an article linked here some months ago from a Chris Cook describing how Brent could be manipulated.
Lets look at two deals that were done at the onset of the Bush Administration:
1. British Petroleum acquired Arco (Alaska’s north slope producer, #1 supplier to California for fuel). That looked like a great deal for BP?
2. T. Boone Pickens hedge fund, TBC Capital, LLC has done huge profit taking during Bush’s presidency (less the collapse in oil pricing late in 2008). Understand for the late 80’s and 90’s he was dabbling in water venture (Ogalala aquifer under the Texas pan handle) with zip in profits (smart guy). Then he gets into hedge fund and is a genius? False positive. His only strategy was long oil (betting on it continual ascention). He is a crook. Now he is splirting out this crap to cover his tracks. How do you think the oil buddies of George H.W. Bush have done in Midland, Texas? Oil boom again. And we are just taking it. Sad.
We have got to find the courage and patience to prosecute these thugs. If not this “federal loop hole” will rear its dragon head again down the road (for our children’s world).
A President(s) must be incarcerated. No joke!
-single firm controls 37 percent of cushing storage.
-same firm able to move w. canadian, etc, crude to cushing via earlier pipeline reversal.
-cushing inventory build affects nymex pricing and forward curve.